Reporting season can be a tumultuous time for investors, full of all the drama, intrigue and revelation of a good spy movie. This year, perhaps more than others in recent memory, we believe there is a heightened level of risk in three key areas of the broader market. Overlay this with the potential ‘Russian-Roulette’ wheel that is Donald Trump, and you have the makings of a very interesting month ahead.

A lot of optimism riding on resources

Resources stocks have surged over the past few months in line with the prices of iron ore, crude oil and other benchmark commodities. The prospect of massive infrastructure spending in the US and the stabilisation of Chinese economic growth, in addition to improving PMI[1] data has also supported the ‘return of resources’ theme. As investors’ scepticism has turned to optimism, many stocks’ share prices have skyrocketed, and now contain (beyond elevated prices just being maintained) an expectation of further price rises in the future. Given the volatility of manufacturing demand from China, and the lack of details surrounding Trump’s infrastructure spending plan and outright speculation in setting key commodity prices, this level of optimism carries a good deal of risk.

Figure 1. Prices of iron ore and oil against the ASX Metals & Mining Index
Source: Thomson Reuters Datastream

Trepidation over Christmas retail sales

This same optimism has failed to translate to the domestic retail sector, where trepidation over the outcome of the most recent Christmas trading period is rife. In particular, there are concerns that aggressive early discounting in November led to softer volumes over the holidays. Casualties of confession season already include well-known retailers such as Oroton, Billabong and Shaver Shop and the coming month will likely uncover more challenges within the sector. Lingering anxiety over the encroachment of online retail giant Amazon into the Australian market has only compounded the pressure on the sector, and is unlikely to be abated in the near term. Of course, in broad sell-offs of this nature, there are opportunities to pick up those stocks that have been unfairly ‘tarred with the same brush’. We believe retailers resistant to online disruption and discounting, typically control well-known brands or market products, which require interaction and physical touch such as shoes, jewellery or furniture. We will be paying close attention to the ABS retail trade data for December, due to be released on 6 February.

Figure 2. Monthly retail turnover (ex-food) – growth on pcp
Source: ABS

Growth stocks in the mid-market continue to be a minefield

Retailers haven’t been the only casualties of pre-reporting season misgivings. Midcap growth stocks, the recent darlings of the market, have become a minefield, with expectations and share prices tumbling back to earth. Such results are a stunning reminder of the binary outcomes of ultra-high P/E stocks, whose onerous expectations and extrapolation of success can lead to spectacular price reactions if they disappoint or downgrade. Since their recent peaks, Bellamy’s (down 71%), Aconex (down 66%), Sirtex (down 59%) and Blackmores (down 44%) have destroyed a vast amount of investor capital. Whether this is a symptom or a cause of the broader de-rate of mid-cap stocks since August is hard to say as we’ve also observed a broader rotation out of mid and small companies into the large-caps. What has become clear is that investors are scrutinising growth in this space with a newfound intensity.

Figure 3. ASX 200 (ex-50) FY1 P/E since Aug 16
Source: Thomson Reuters, Clime analysis
Successful navigation of the upcoming February reporting season is something all investors seek to achieve. We believe this February will be as much about avoiding the landmines of disappointing growth stocks as it is about identifying undervalued stocks with genuine, sustainable growth. We expect upcoming volatility to provide the opportunity to selectively deploy capital into our most favoured positions. Be aware of inherent risk within resources and retailers and have conviction in backing your best investment ideas.


[1] Purchasing manager index, a leading indicator of resources demand